What Pension Plan Managers Know that Investors Need to Learn
NEW YORK ( MainStreet) Pension plans are benefiting from rising equity markets, and individual investors have a lot to learn from them.
"While many investors are educated well enough to build a disciplined, diversified portfolio, behavioral finance gets in the way," said Peg Chromy Webb, a financial advisor with Wealth Enhancement Group in Minneapolis. "Instead of building the portfolio and making small changes when the stock market rises and bond prices fall, they make radical changes. They buy high and sell low."
Pension plans typically use an institutional disciplined approach that diversifies across interest rate risk, inflation risk, company risk and manager skill, according to Webb.
The principles are the same for individual investors with 401(k) plans or IRAs.
"Individual investors aren't regulated in how they invest in their IRA retirement plans whereas corporate and public pension plans are, so individual investors have degrees of freedom that a corporate pension plan doesn't normally have," said Alan Brown, senior advisor with Schroders Investment Management.
The funded status of the typical U.S. corporate plan increased to 91% last month, according to Bank of New York's (BNY) Investment Strategy and Solutions Group (ISSG).
"With the funded status of these plans continuing to move higher, we see growing interest from plan sponsors in strategies that can lower exposure to market volatility," said Jeffrey B. Saef, managing director of BNY Mellon and head of ISSG.
ISSG found that public pension plans, endowments and foundations also exceeded their targets; however, corporate plans led the three groups as public equities outperformed alternatives. Year to date, the funded ratio for corporate pension plans is up 14.7 percentage points.
"Individual retirement investors need to look for assets that are over and undervalued and act accordingly," Brown told MainStreet. "For example, an overvalued asset today is government bonds. Don't own any but if you do, have only a short duration exposure. As for undervalued equities, I think equity markets are basically fairly valued and no longer clearly cheap. Within that, the big opportunity is in emerging market equities, which have underperformed the S&P 500 by 30% this year."
Assets for corporate plans rose 2.6%, outpacing the 1.7% increase in liabilities. Plan liabilities are calculated using the yields of long-term investment grade bonds. Lower yields on these bonds result in higher liabilities.
"Individuals need to be thinking about the same kinds of decisions that a corporate pension plan would be considering," said Brown. "Think of your assets and liabilities in the way a pension plan does, which is holistically. For example, when the wealth of your pension is getting better or when your implicit funding ratio is getting better, ask why? Probably today it would be because equities have been on a tear."